Know How to Use a 457 Retirement Plan Account

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A 457 retirement plan is used by state or local government employees. Those who work for a tax-exempt nonprofit can also take advantage of a 457. But this is often seen as one of the more complex employer-sponsored plans. There are several variations.

When you go to withdraw from a 457, it can get a little tricky. What are the different 457 retirement plans, and how do they affect your retirement?

Two Types of 457 Plans

There are two types of 457 plans: the 457(b) and the 457(f).

The 457(b) is the most common retirement plan. It offers a tax-advantage plan to government employees and nonprofits. It operates like a 401(k) plan with several exceptions.

The 457(f) plan is only offered to highly compensated executives in tax-exempt organizations. It’s considered a salary-deferred plan. Because it restricts when you can leave employment to collect the funds, it is called the “golden handcuffs” plan.

This article will discuss the 457(b) plan.

457(b) vs. 401(k) Plans

Just like a 401(k) plan, the 457(b) plan allows workers to contribute pre-taxed money into a retirement account. But unlike a 401(k), it’s very rare that the public employees receive contribution or matches from their employer. Also, 457(b) plans usually incur more fees than 401(k) plans because they tend to have fewer participants.

Many are run by small municipalities or school districts.

Like the 401 (k) plan, the account grows tax-free over the years. However, with both, you must pay taxes on all the funds you withdraw.

Contribution Limits on 457(b)

The 457(b) has a dollar limit on annual contributions. In 2024, the maximum an employee can contribute is $23,000.

But there are some instances where workers can contribute more. For example, the employer permits catch-up contributions. This means that employees over the age of 50 may pay an additional $7,500 a year. This brings the contribution in 2024 as $30,500 a year.

Some plans provide for a “double limit catch-up” rule. This allows participants who are nearing retirement to make up for years they didn’t contribute to the plan even though they were eligible.

So, if you’re retiring at 50, you can do double limit catch-up starting at 47. This is called the three-year rule.

But here’s where it gets complicated. You can contribute double what is the standard amount for contributions. For example, you contribute $46,000 instead of just $23,000. You also have the option to make up the difference in contributions that you didn’t make when you were eligible.

So, for 2024, that sum is $46,000 plus all the money you didn’t put in but could have in previous years. But the latter choice is only for those not using catch-up contributions for age 50 or over.

Are you confused yet? It’s a convoluted formula and many plan administrators choose not to offer the second option. Those who do offer it ask the employee to provide the payroll records to show they did not contribute the full amount that they could have in the past years.

Early Withdrawals Are Challenging

It’s harder to do an early withdrawal from a 457(b) retirement plan. But it can be done if you have an unforeseeable emergency or hardship.

With a 401(k) plan, you could withdraw funds (with a penalty) to purchase a house or pay college tuition. But you can’t do that with a 457(b) plan.

It has to be something catastrophic, like your house burnt down. The enactment of the SECURE Act 2.0 enables withdrawals for other events. These include:

• federally declared disasters
• survivors of domestic abuse
• emergency expenses of up to $1,000
• those paying long-term-care premiums

You must repay these withdrawals within three years, or the funds will be taxes as income.

If your plan allows it, you can take a loan from the 457(b). The maximum amount you can borrow is 50 percent of the vested account balance or $50,000, whichever is less.

This loan must be paid within five years. And you’ll be required to make payments at least quarterly.

Early Distributions

Early distributions for those before the age of 59½ are not subject to the usual 10 percent penalty. There are many participants who work as police officers and firefighters. They have the potential to retire early because of a disability. The result is 457(b) plan participants don’t incur a penalty.

457(b) Retirement Plan More Restrictive

When comparing the 457(b) retirement plan to the 401(k), there are some big differences regarding withdrawals. You can withdraw money early from a 401(k) plan, but you will incur penalty fees.

You can only withdraw early from a 457(b) plan under limited circumstances. Both allow you to take out loans with the plan administrator’s permission.

A big con with a 457(b) plan is the lack of employer contributions to the plan. That’s a significant benefit the private sector workers with their 401(k) plans enjoy.

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